Before buying a home can become a reality, you will need to find out what you can afford. Knowing what you can afford focuses your search and protects you from getting your hopes up in vain over a house that you later discover is out of your price range.

Finding a Price Range

Finding out how much you can afford will not necessarily determine whether or not you can buy a home, but it will tell you about how much of a loan you can qualify for which will help you decide what price range you should be looking in to buy your home.

To discover how much you can afford to spend on your new house, you will need to see how much you can afford to pay each month toward a mortgage loan, including principal, interest, taxes and insurance (PITI).

In general, lenders prefer that your monthly mortgage payment is about 28% or less of your gross monthly income. For example, if you make $40,000 a year, the maximum monthly payment you could afford would be $1000.

Lenders also look at your debt in comparison to your income. Your total monthly debt payments, including your mortgage costs, car loans, student loans, credit cards and others, should not exceed 36% of your gross monthly income. Lenders call this comparison a back end ratio.

Don't Lose Heart

Don't let the ratios dishearten you. Depending on the type of loan, the interest rate of the loan, and the down payment made, you may be able to afford more than it seems. The best way to determine how much you can afford is to contact a lender to prequalify for a mortgage. You may prequalify with Simmons First by contacting a mortgage office at any of our convenient locations.

Your down payment is a major deciding factor in your ability to buy a home and how much you can afford. A down payment is the cash you put down to buy a house. Your down payment plays a part in deciding your interest rate and the amount of your loan. It also shows the seller and lender your financial commitment to the purchase.

Most lenders require your down payment to amount to somewhere between five and twenty percent of the value of the house you are buying. If you are unable to pay a sizable down payment, there are non-conforming loans with low or no down payments to help you. Also, there are many sources besides personal funds that may be of assistance. However, most lenders require that you pay for private mortgage insurance (PMI) if the down payment is going to be less than 20% of the value of the house.

Even if you have 20 percent for a down payment, you may choose to put down less, pay for private mortgage insurance and hold on to the cash for another purpose. Putting down less will create a larger monthly payment - your loan amount is higher - but could give you a larger tax deduction.

In deciding how much to put down, you will need to decide if you are more concerned about your initial cost or your monthly cost. The larger your down payment, the smaller your loan amount, and the smaller your monthly payments.

10% Down

20% Down

Purchase Price

$100,000

$100,000

Down Payment

$10,000

$20,000

Loan Amount

$90,000

$80,000

Monthly Payment

$600

$530

Making a larger down payment can also lower your interest rate making your monthly payments even smaller.

Before settling on the amount of your down payment, make sure that you take the closing costs into consideration. Closing costs are fees involved in buying a house that are not covered by a mortgage. It is easy to neglect the closing costs when you are trying to increase your down payment.

Building a Down Payment

Depending on how far into the future you plan on buying that new home, you may have time to save up some money for the down payment, and maybe even invest some of that money to get an extra return on it.

Start off by setting up a budget that includes putting some money in savings and/or investments. In choosing a savings or investment strategy, it is a good idea to contact a financial advisor.

A parent or other individual can give up to $10,000 a year to another person without having to pay gift taxes. Gifts and grants from a relative and non profit organizations can be just the thing to help you reach your ideal down payment amount. A "gift letter" is usually required with a gift or grant. The gift letter simply states that you do not have to repay the amount of money given.

After deciding that you can afford to buy, your next step is to pick a type of mortgage loan that best suits your needs.